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Will the Bush plan work?
Economists are divided about the effects of the president's $674 billion stimulus proposal.
January 7, 2003: 6:26 PM EST
By Mark Gongloff, CNN/Money Staff Writer

NEW YORK (CNN/Money) - President Bush unveiled his plan Tuesday for a package of tax cuts and government spending meant to bolster the economy and his chances for re-election in 2004.

While the president's plan might help with the second goal, observers are sharply divided about its effectiveness in fixing the economy.

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The plan calls for the government to spend about $674 billion in the next 10 years, about half of which will go toward eliminating the tax investors pay on stock dividends.

The plan is far more ambitious than many analysts expected -- just last week, most thought Bush would call for only $300 billion in stimulus -- reflecting a new, aggressive stance by the administration toward an economy that has been sluggish for about a year following the 2001 recession, with little or no job growth and a prolonged bear market in U.S. stocks.

Bush, remembering the lesson of his father, who lost a presidential re-election bid in 1992 because of accusations that he was too lackadaisical about the economy, fired key members of his economic team late last year and promised to start the new year with a plan to fix the economy.

And some economists think the current president has gone a long way toward fixing the economy simply by intensifying his focus on it.

"When people report that consumer confidence and business confidence are down, those things have less to do with the fundamental state of the economy than with this kind of funk, this uncertainty, this uneasy feeling," said James Padinha, economic strategist at Arnhold & S. Bleichroeder. "So anything [the government] does to say, 'Look, we understand, try this remedy' -- I'm all for anything like that."

Jumpstarting stock prices

The plan's centerpiece, the dividend tax cut, is intended to goose U.S. stock prices, which have fallen three years in a row. A healthier stock market would hopefully inspire business confidence and spur corporations and consumers to spend more.

"The biggest problem the economy has had in the past year has been the downtrend in equity prices, which is damaging spending by people who are in their 40s, 50s and 60s, who have had their retirement plans smashed," said Rory Robertson, interest rate strategist at Macquarie Equities USA.

"At the corporate level, the big downturn in equity prices has smashed company pension funds, forcing companies to put more money back into their pension plans," Robertson added. "Anything that helps to stop [the downturn in equities] could be helpful."

Bush's plan also calls for some of the tax cuts passed in 2001 and scheduled to take effect in 2004 and 2006 to take effect in 2003. It also sets a schedule for the elimination of the so-called "marriage penalty" on two-earner couples.

The tax changes, which Bush claimed would give about 92 million Americans an average tax break of $1,083 in 2003, could have a more immediate and real impact on consumer spending, which fuels more than two-thirds of the total economy. (For a closer look at how much you may save if the president's proposals are enacted, click here.)

"The personal income tax cut could be a boost of $50 billion to disposable income, and some of that could be felt when they actually change the tax withholding schedule, which could be in the spring or summer," said Joshua Feinman, chief economist at Deutsche Bank Asset Management. "Then there might be a little bit of rebate check, too. All of this might be a little more of short-term shot in the arm than the dividend tax cut."

But critics -- including congressional Democrats -- have noted that most of the tax breaks would go to wealthier Americans, who may have less immediate need for the cash.

'Supply-side medicine for demand-side problem'

Meanwhile, small businesses might not take advantage of the president's proposed incentives to spend money to invest money until they're sure demand is rising enough to justify increased production. The short-term stimulative effect of the president's plan, then, could be muted.

"The problem with the economy right now is insufficient demand, not supply," said Scott Brown, chief economist at Raymond James & Associates. "The meat and potatoes of this plan is supply-side medicine for a demand-side problem."

Democrats Monday released a plan of their own, amounting to about $136 billion, that included a one-time tax rebate of $300 per person, an extension of unemployment benefits, $31 billion to the states and a $50,000 deduction for small-business investment in 2003.

The Democrats said their plan generated more short-term stimulus than the president's plan, and some economists agreed.

"The Democrats' proposal is more effective. I might quibble on some of the details, but it's completely focused on the short term," said Max Sawicky, an economist at the Economic Policy Institute.

Of course, the President's plan now goes to Congress, where it will be debated by Republicans and Democrats. Many economists think the final stimulus package will combine elements of both the President's plan and the Democrats' plan.

Relief for workers, none for states

The president's plan would give about 1.2 million unemployed workers an average of $3,000 apiece in "personal re-employment accounts," which will pay for their job training, child care and moving expenses while unemployed. If these people find jobs within 13 weeks of becoming eligible for the payment, they get to keep the balance, a job-hunting incentive.

The plan also calls for an extension of unemployment benefits, which expired for many people at the end of 2002.

But critics say that, unless the plan stimulates demand in the short term, it won't give unemployed people what they need most -- jobs.

"The bulk of the resources [in the plan] are irrelevant to the current employment situation; they don't take effect until later," Sawicky said.

And cash-strapped states will get no relief under Bush's plan. Many economists are concerned that state efforts to balance their budgets -- including tax hikes and spending cuts -- would offset much of the positive effect of any federal stimulus plan.

The president had considered offering about $10 billion to the states, in response to these concerns and to help win Democratic approval of his plan, but decided Tuesday to scrap the offer.

While states are required to balance their budgets, the federal government is not. Critics fear that the Bush plan would swell federal budget deficits, which would in turn force the government to issue more bonds, making those bonds more available and therefore cheaper, making the interest rates on those bonds higher, since investors would want a better return on the cheaper bonds.

Higher bond yields would lead to higher interest rates on other long-term debt, including mortgages and long-term corporate loans, which would slow down economic activity in the long run.

But many economists say it's acceptable, even desirable, to run a federal deficit when the economy's in trouble, since the government's tax revenue depends, in part, on how well the economy is doing.

"The alternative [to a stimulus package] could be worse," said James Glassman, senior U.S. economist at J.P. Morgan. "If the economy flounders, then there's a loss of revenue, worsening the budget situation -- it could even be worse than the measures you take in the short run to fix the economy."  Top of page




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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.